Good governance and improved institutions can drive Europe’s growth

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I was in London last week for a conference hosted by the European Commission and the London School of Economics and Political Science. Its purpose was to take stock of what has worked in regional development in the European Union (EU), look at existing institutional ingredients, and explore the policy mix that could help bring Europe’s lagging regions closer to the center of economic development.

What are lagging regions?

On the one hand, these are regions that didn’t converge to the EU average over the past decade or so. They spread from Portugal, Spain and Italy, to Greece. On the other hand, there are regions with a GDP per capita below 50 percent of the EU average - these are found in Bulgaria, Romania, Hungary and Poland. Like a boomerang they encircle the southern and eastern borders of the European Union. And although they are predominantly located at Europe’s geographic periphery, periphery should not be the defining narrative of their destiny.

In 2012 the World Bank published a report entitled “Golden Growth: restoring the lustre of the European economic model”. It dubbed the EU a “Convergence Machine” by virtue of the Union’s unprecedented development model and its success in helping new member states overcome the middle-income trap to achieve high-income status. It took access to markets and better institutions to support this growth story. Processes of convergence at the national level were paralleled by internal convergence processes which saw some regions fare better and others lag behind, but everyone grew.

So what will it take for lagging regions to converge even faster?

Improvements in institutions matter. Romania’s regions increased their GDP per capita (PPS) between 2.6-3.2 times in the period 2000-13, with some of the highest growth registered in the West region, which saw an increase from Euro 5,100 to Euro 15,700. Lithuania’s GDP per capita increased from Euro 7,500 to Euro 19,600 Euro and Latvia’s grew from Euro 6,900 to Euro 17,000 during the same period of time. All of these countries witnessed some of the highest aggregate improvements in government effectiveness from 1996-2014, an effort which paid off through large influxes of Foreign Direct Investment.

Good policy environments are critical to growth. Geography may be a barrier to integration and reduce access to markets, but with the right policies in place the challenge of geography can be overcome. The experience of the Scandinavian and Baltic states that have grown rapidly despite being on the periphery, speaks to this eloquently. They have attracted investment despite their location through good policies. Estonia ranks 16th in the world in issuing construction permits, whilst Cyprus is 147th. Lithuania is 8th in opening a business, while Malta ranks 132nd.

A successful policy approach to surmount geographical limitations is to ensure access to markets through trade and logistics improvements, as well as moving to best practice on the business environment front.

A focus on external, rather than internal, convergence is needed. The experience of Western European countries shows that as an economy matures, the disparities between regions tend to flatten. Consequently, the focus of regional development policies should be on connecting the hinterland to leading regions and dynamic EU urban centers.

Cities are the engines of growth. Bucharest grew at a compound annual rate of 8.75 percent over 2000-13, Romania grew at 7.85 percent. Sofia grew at 8.27 percent, whilst Bulgaria recorded a 6.32 growth over the same period. Budapest, Bratislava, Prague portray similar stories. Therefore, local and regional policies should support the transformation of cities into urban agglomerations and create opportunities for people from lagging regions to have access to surrounding urban agglomerations. When capital cities and leading regions grow, lagging regions will grow.

Rethinking EU regional policies should have an emphasis on institutional performance. This can create a space for competition in absorbing EU resources destined to support greater connectivity and inter-regional integration. The Romanian city of Alba Iulia, for example, has modernized its public administration and urban development department to better absorb EU funds. This has had spillover effects on the overall capacity of the city to manage its cultural heritage and improve its investor rating. Cities across the EU can learn from each other in implementing successful reforms at the local level. The World Bank Group has recently launched sub-national Doing Business evaluations in Romania and Hungary to identify best practices across cities in improving their business environment.

Finally, national polices should not be framed in terms of leading versus lagging regions, but should take into account distinct regional needs. A prime focus should be on ensuring equal access to services for everybody by providing all people with the necessary capital endowments, including quality education, healthcare, access to basic services, functioning land/housing markets, connective infrastructure to growing cities and markets so that they could have the same start in life as people in leading regions.

Authors

Elisabetta Capannelli

World Bank Country Manager, Romania

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